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January 2012
Today's economic news can distort your sense of fiscal reality. Here are three errors many people are making — and how you can avoid them.
The last time I checked, I was standing on Planet Earth — not on Jupiter or Mars or some other distant world.
But it seems not everyone believes that.
"What planet are you on? Get out in the real world," a gentleman named Tony recently wrote me in an e-mail. "I lost my job, my house is under water, my retirement funds are down 25%, I can't get .02% interest on a savings account and my health-care costs are going up 30% a year. ? I can't tell you how ridiculous you sound. It's like you are living in some other universe."
Tony's pain is real, and he has my sympathy. And he's not alone; thanks to bad economic news over the past four years and its resulting market volatility, many people like Tony are on edge — raising questions as to whether I'm on another planet when I mention any positive news or outlook about the economy.
But is Tony's reality everyone's reality?
No. Just because Tony or someone you know is suffering economically doesn't mean that everybody is having the same experience.
This is one of three fundamental errors that many people are making in today's economic environment, which can lead to a distorted sense of reality. If you recognize yourself in the following descriptions, it's time to refocus on what's real and what isn't.
Error No. 1: Representative bias
The first mistake is viewing your own circumstances and mentally extending them to the entire country. Your personal history and situation are not necessarily representative of what's actually happening.
Psychologists call this small sample-size representative bias. A person who just lost his job believes that the entire U.S. economy is bad. When real estate prices in one part of the country are down, people in that area are convinced that the real estate market is equally bad everywhere. And so on.
Error No. 2: Misguided anxiety
Many people are worrying more about what might happen instead of what actually is happening.
This past summer and fall, much of the stock market's volatility has stemmed from worries that Greece and Italy might default on their debts. They worry that such an event might disrupt the value of the euro and, by extension, the dollar — which, in turn, might adversely impact the U.S. budget deficit. The result, they fear, might be rising taxes and lower stock prices.
The word might appeared four times in the above paragraph. We could just as easily have said "might not." Might is a powerful word. But even more powerful is the word is. So let's take a quick look at some of what actually is happening.
- As I write this, Greece has not defaulted — and it doesn't matter much if it does. Fully 92% of global fund managers surveyed by Bank of America said they expect Greece to default, and that securities are already priced accordingly. This means that actual default won't matter much.
- If Greece does indeed default, it'll join a long list of others that have done the same. In the past 30 years, many European and Latin American countries have defaulted on their debts, some repeatedly. The list includes Turkey in 1982, Mexico in 1994, Russia in 1998 and Argentina in 2001. The world survived those defaults and will survive the next ones.
- U.S. unemployment dropped to 8.6% in November, the lowest since March 2009, down from 9% in October. And 120,000 new jobs were added, the Labor Department said. The jobless rate is still too high, but it's steadily moving in the right direction.
- Spending on equipment through September for the 140 non-financial companies in the S&P 500 Stock Index that have released data is $149 billion, topping the $146 billion that these same companies spent in all of last year and just short of the $169 billion peak in 2008, according to Bloomberg.
- Rail shipments in the U.S. are at their highest in three years, according to the Association of American Railroads. Rising volumes show the economy is growing.
- Gross Domestic Product jumped 2% in the third quarter, doubling the growth rate in the second quarter, according to Bureau of Economic Analysis. Third-quarter GDP reached $13.4 trillion, topping for the first time the peak set in 2007.
- Manufacturing output, which makes up 75% of all U.S. factory production, rose at a 4% annual rate in the third quarter as measured by the Federal Reserve's industrial production index.
Error No. 3: Recency bias
Daily headlines and up-to-the-minute TV reports on the economy have nothing to do with your long-term financial situation.
Some people complain when their monthly investment statement reflects a decline in value. But those statements only show the results of the past 30 days. I am always fascinated when people compare their current value to that of a month ago. Why not compare it to a year ago, or to ten years ago?
The reason we don't is due to something psychologists call recency bias — a natural tendency to ascribe greater weight to recent events than to those that occurred a long time ago. So the next time you catch yourself examing your investment results, ask yourself: To what date are you making a comparison, and is that comparison serving any useful purpose?
It's easy to make any of these three errors. So before you make any crucial financial decision that will affect your future and that of your family, talk first to an independent, objective, fee-based advisor who can help you determine what's real — and what's perhaps only in your imagination.
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